Since earlier this year, we’ve all witnessed the economic downturn happen. The markets of tech stocks and crypto have lost big parts of its value. Now, investors get back to work after a slow summer filled with holidays instead of term sheets. We all wonder what the fall of 2022 in venture capital will look like, with this current uncertain VC climate.
What is certain now is that the VC party that started in 2020 and reached its crescendo in 2021 is over. The startup founders that I meet through the Fast Track Malmö accelerator all ask us the same thing. What does the current market mean for seed investments? Will we be able to raise capital from VC funds as planned?
Startups at the earliest stages of development are especially dependent on access to external capital from investors. That is because it might be impossible to switch to profitability, many of them have much potential but no revenue yet. For most seed-stage startup founders, failing to raise capital means the end of your startup.
In one way, it seems like it will be impossible to raise a seed round right now as valuations of tech companies on stock markets nosedive. But from another perspective, VC funds need to deploy the record funds they have raised. With IPO markets plummeting, it is obvious that late-stage investments have been affected. But what happens in the early-stage markets?
Compared to stock markets, changes in trends happens slowly in VC. Even worse, the data to identify the trends move even slower. That is especially true in the seed stage as many wait multiple months to make financing rounds public.
The data has arrived for Q2 2022, and it shows a drastic slowdown of 38 % in dollars invested in European VC compared to the same quarter last year according to Crunchbase. When comparing to Q1 2022, there was a sharp decline of 24% of dollars invested. However, the slowdown was clearly driven by the drop in late-stage deals. For the European seed stage, we don't see the same break in the trend. The amount invested in this market in Q2 2022 only decreased 5% quarter over quarter.
But what will happen now, as we go into a new investment season? Will we see the same numbers in the seed stage, when the data lag has caught up? Or can we expect seed funding to keep strong? Since I’m no fortune teller, I decided to ask seed VC funds how they plan to invest for the rest of 2022.
We asked 22 European VC funds how their plans have changed in 2022, with mainly the economic downturn in mind. Out of the funds that responded, 96 % invest in seed, 82 % pre-seed, and 46 % in Series A. 78 % of respondents invest all over Europe or globally, while the rest invest regionally.
Of all the respondents, there were 43% partners, 33% principals, and 23 % associates. On average the funds that participated in the study do 10,7 investments a year. The responses were collected between June-August 2022.
On the question of whether they have changed their plan on the number of new investments for this year, two-thirds answer that they will stick to their original plan. Clearly, VC investors have funds to deploy and they continue to see opportunities in this market.
However, we can expect a decrease in pace from a third of funds. As 18% are planning a sharp decline of 30-50% in their number of new investments. The rest, 14% of the respondents, foresee a smaller decline of 10-20%.
We also asked about the reasons for slowing down, and the most common reasons were that the fund:
- Don't feel comfortable placing bets in uncertain times
- Reserve capital or time for portfolio companies instead
- Have uncertainty in access to capital from LPs
When asking about valuations, we see an obvious trend where investors agree. All funds responded that the valuations of their new investments will decrease, as no one answered "No" to this question. However, to what extent it will change is up for debate. Half believe it will be a limited decrease of 10-20 %, while the other half expect a drastic decrease of 30-50%. This means that we’re going back to the valuations we were seeing before 2020.
Not only valuations are expected to decrease, but also ticket sizes according to half of the VC funds. As 36 % expect to decrease ticket sizes by 10-20 % and 14 % by 30-50 %. However, the average decrease in the market will be lower than for valuations. In other words, we can expect investors to go back to taking bigger chunks of startup captables than what we've been used to during the past 2 years.
For the past 2 years, we've seen investors fight to achieve 10% of the equity in a company when investing in a round. During 2022 we will probably see a market where lead investors go back to having 15% of a company's captable.
In the study, we also asked how the criteria for investment might have changed. On the public stock market and in late-stage investments we've seen a big push towards profitability and decreased attractiveness in growth. Is this also the case in early-stage investments? According to our study, metrics have indeed increased importance in investment decisions for 68 % of seed VCs.
However, the growth rate continues to be as important as before for seed startups, or even increase in importance for 27% of the investors. We also see that the market has an increased priority as an investment criterion among 32% of investors. That is probably because some markets slow down while others go through radical changes where opportunities open up for startups.
When asking the VC investors which industries they think have lost attractiveness, crypto is one to stand out as 35% of the respondents consider it less interesting this year. That is no surprise as the crypto markets have collapsed.
"We already see a slowdown in funding volume for crypto companies. But overall, we don't believe the space has become less attractive for builders. We rather see a re-emphasis of investors on projects that have a truly unique ambition.” - Philipp Handel, an investor at the German seed fund LaFamiglia
The hype that has been around consumer tech since the pandemic seems to be cooling off since one-fourth site it is a less interesting industry.
We also asked what industries have become more attractive. Climate tech has gained in attractiveness this year to 38 % of investors, which is probably an effect of the more urgent message around the climate crisis. However, enterprise SaaS and fintech are also gaining interest as VCs turn to less risky investments in a shaky market.
Looking ahead over the next couple of months, we can now say with pretty good confidence that the seed VC market won’t collapse. We will see valuations coming down and some fewer deals, and the crazy rounds won’t happen anymore. If you’re operating in a good market with a good team and metrics, you will be able to raise. No need to extend your runway until 2024, many investors are still here and hungry to invest!